Findlay Park: US Smaller Companies

James Findlay, joint manager of Findlay Park US Smaller Companies, an equity fund, believes cash is king. He aims to invest in businesses that throw off excess cash flow at times when while these companies are shunned by stock market investors.

This year, Mr Findlay arrived at the annual meeting of Warren Buffett’s Berkshire Hathaway company at 7am to get a good seat.

The US smaller companies fund is backed by multi-manager specialists at Jupiter Asset Management, and Mr Findlay says his main aim is to avoid losing money on any individual holding. The fund has closed to new investors, and Findlay Park does not take telephone calls from members of the public.

Smaller companies have become a the focus for rising of investor interest after a strong period of strong performance. Mr Findlay, who worked at investment management group Foreign & Colonial from 1983 to 1997, notes that small cap portfolios typically trade at a price/earnings ratio higher than the overall equity market. By contrast, the Findlay Park US Smaller Companies fund usually has an average price/earnings ratio which is below the stock market.

He and his colleagues normally invest in businesses that are briefly out of fashion among equity investors. They aim to buy companies that can keep increasing cash flow and earnings in differing economic conditions before markets spot their strengths. That in turn means the holdings ought to gain from improving valuations as fund managers react to the companies’ merits.

To spot the cash cows, Mr Findlay and his colleagues look for companies that buy back their own shares – about 60 per cent of the businesses in the fund have repurchased their stock in recent years. They believe share buy-backs reflect a high level of excess cash flow and the right attitude to improving shareholder value on the part of thefrom management. Moreover, buy-backs are frequently a sign that executives believe their shares are cheap and that they expect sales and profits to rise. Mr Findlay also looks for groups where managers own a high proportion of the equity.

He likes companies whose where business grows as the customers spend more, noting that they tend to have extremely high free cash flow. These include radio, billboards, advertising agencies and even barges. Such groups gain from bigger capital investment by their customers, require little working capital and throw off cash to their shareholders.

He tends to avoid “high growth” companies, saying that many of them require regular, big injections of capital. Mr Findlay rarely invests in groups that will need equity financing to grow, noting that their share prices often decline steeply in bear markets or when results fail to hit forecasts. He typically avoids unpredictable, fashionable industries such as technology.

The signs which ring alarm bells for Mr Findlay include small companies that move to a new head quarters – he says many of them fail to hit analysts’ forecasts the next year. He tries to avoid businesses with corporate acquisition departments, and considers selling a small cap stock when more than one Wall Street stock broker recommends it. He is wary of a fall in the return on newly invested capital. And he believes the availability of excessive new equity capital is a sign of high investor enthusiasm. That often shows that a sector’s performance has hit a peak, or will do so soon, he argues.

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